Monday, December 13, 2010

Today's Links

Excerpt: What we’ve been dealing with ... is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years. ...

What the government should be doing in this situation is spending more while the private sector is spending less, supporting employment while those debts are paid down. And this government spending needs to be sustained:... spending that lasts long enough for households to get their debts back under control. The original Obama stimulus wasn’t just too small; it was also much too short-lived, with much of the positive effect already gone. ...

But wouldn’t it be expensive to have the government support the economy for years to come? Yes, it would — which is why the stimulus should be done well, getting as much bang for the buck as possible.

Which brings me back to the Obama-McConnell deal..., the tax-cut deal is likely to deliver relatively small benefits in return for very large costs. ... Tax cuts for the wealthy will barely be spent at all; even middle-class tax cuts won’t add much to spending. And the business tax break will, I believe, do hardly anything to spur investment given the excess capacity businesses already have.

Excerpt: Credit card offers are surging again after a three-year slowdown, as banks seek to revive a business that brought them huge profits before the financial crisis wrecked the credit scores of so many Americans.

The rise is striking because it includes offers to riskier borrowers who were shunned as recently as six months ago. But this time, in contrast to the boom years, when banks “preapproved” seemingly everyone, lenders are choosing their prospects more carefully and setting stricter terms to guard against another wave of losses.

For consumers, the resurgence of card offers, however cautious, provides an opportunity to repair damaged credit and regain the convenience of paying with plastic. But there is a catch: the new cards have higher interest rates and annual fees....“Lenders want to prove to themselves that it is worth taking a higher risk,” said Brad Jolson, an executive of the decision management company FICO, who has helped several card companies analyze their customer base....

Lenders have taken $189 billion in credit card losses since 2007, according to Oliver Wyman Group, a financial consultancy. That was a significant part of the $2 trillion or so that banks are estimated to have lost since the crisis began, and a contributor to the government bailout of the banking system.

Excerpt; last week, an analyst at the Royal Bank of Scotland advised clients to hedge against the risk that a flood of cash into China, coupled with soaring inflation, could result in a “day of reckoning.”

A sharp slowdown in China, which is growing at an annual rate of about 10 percent, would be a serious blow to the global economy since China’s voracious demand for natural resources is helping to prop up growth in Asia and South America, even as the United States and the European Union struggle.

And because China is a major holder of United States Treasury debt and a major destination for American investment in recent years, any slowdown would also hurt American companies....

Beijing has moved recently to tame its domestic growth and rein in soaring food and housing prices by raising interest rates, tightening regulations on property sales and restricting lending.

Excerpt: Under the Dodd-Frank financial overhaul, many derivatives will be traded via such clearinghouses. Mr. Gensler wants to lessen banks’ control over these new institutions. But Republican lawmakers, many of whom received large campaign contributions from bankers who want to influence how the derivatives rules are written, say they plan to push back against much of the coming reform. On Thursday, the commission canceled a vote over a proposal to make prices more transparent, raising speculation that Mr. Gensler did not have enough support from his fellow commissioners....

Clearing involves keeping track of trades and providing a central repository for money backing those wagers. A spokeswoman for Deutsche Bank, which is among the most influential of the group, said this system will reduce the risks in the market....

Perhaps no business in finance is as profitable today as derivatives. Not making loans. Not offering credit cards. Not advising on mergers and acquisitions. Not managing money for the wealthy.

The precise amount that banks make trading derivatives isn’t known, but there is anecdotal evidence of their profitability. Former bank traders who spoke on condition of anonymity because of confidentiality agreements with their former employers said their banks typically earned $25,000 for providing $25 million of insurance against the risk that a corporation might default on its debt via the swaps market. These traders turn over millions of dollars in these trades every day, and credit default swaps are just one of many kinds of derivatives...

The result of the maneuvering of the past couple years is that big banks dominate the risk committees of not one, but two of the most prominent new clearinghouses in the United States. That puts them in a pivotal position to determine how derivatives are traded.

Under the Dodd-Frank bill, the clearinghouses were given broad authority. The risk committees there will help decide what prices will be charged for clearing trades, on top of fees banks collect for matching buyers and sellers, and how much money customers must put up as collateral to cover potential losses.

Perhaps more important, the risk committees will recommend which derivatives should be handled through clearinghouses, and which should be exempt.

Regulators will have the final say. But banks, which lobbied heavily to limit derivatives regulation in the Dodd-Frank bill, are likely to argue that few types of derivatives should have to go through clearinghouses. Critics contend that the bankers will try to keep many types of derivatives away from the clearinghouses, since clearinghouses represent a step towards broad electronic trading that could decimate profits.

Excerpt: There will be no Eurobond, no increases in the EU’s €440bn (£368bn) rescue fund, and no mass purchases of Spanish and Italian bonds by the ECB. Nothing. The system is politically and constitutionally paralysed. Spain and Portugal will be left nakedly exposed before their funding crunch in January.

It is entirely predictable that Angela Merkel and Nicolas Sarkozy would move so quickly to shoot down last week’s Eurobond proposal, issuing pre-emptive warning before this week’s EU summit that they will not accept “a bundling together of all Europe’s debts”....

To those who blithely argue that EMU is a good racket for German exporters because it locks in Germany’s competitive advantage, he retorts that a trade surplus is the flip side of a capital deficit. Germany has seen €1 trillion – or two thirds of its entire savings since 2002 – leak out to fund the EMU party, gutting investment at home. This is toxic for Germany too.

It is no surprise to eurosceptics that Europe should have reached this fateful point where leaders must choose between the twin traumas of EMU break-up or giving up their countries. Nor is it a surprise to an inner-core of schemers within the EU system, who have always calculated that they could exploit such a crisis to catalyse political union.

Excerpt: John Appruzzese, Chairman of the Investment Policy Committee at Evercore Wealth Management, has some very scary numbers about China’s very own QE2 that suggest a possible inflationary bubble that needs to be popped.

Total bank loans in China are $7 trillion– greater than the US economy, which is triple the size of China. In other words China’s inflation might well be “significantly higher” than the 4.4% claimed. More like the 10% inflation in Chinese food prices or more.

Appruzzese reckons that a significant risk from “continued high inflation in China will cause the country’s relative labor and production costs to increase, effectively generating the same result as an appreciating currency without the advantage of additional puchasing power for the imported natural resources.”....

China is the major committment in Evercore’s foreign stock holdings, which Appruzzese is unwilling to cut back until he can be certain trouble is ahead. It made me nervous that he thought China was 80% toward some kind of potential selloff that could be major.

Excerpt: China risks a more abrupt tightening in monetary policy next year after refraining from raising interest rates since October even as inflation accelerated to the fastest pace in more than two years.

Consumer prices jumped 5.1 percent in November, a statistics bureau report showed Dec. 11. A measure of wholesale costs climbed 6.1 percent, exceeding all 28 estimates in a Bloomberg News survey of economists. Even so, the central bank held off over the weekend on the rate move predicted by firms including UBS AG and Mizuho Securities Asia Ltd.

Policy makers’ hesitation may be in part a product of China’s policy of holding down the yuan, as higher returns on deposits and loans would boost prospects for inflows of speculative capital that put pressure on the exchange rate. The danger is that a quicker move to raise borrowing costs next year unsettles the expansion in the fastest-growing major economy.....“If they are overwhelmed by this concern and refrain from a rate hike, inflation will be a big risk next year, and then eventually they will need to rush in tightening.”

Excerpt: The U.S. bond market is giving dollar bulls more reason to be optimistic after driving the greenback higher against the other 16 major currencies since the first week of November.

Inflation-adjusted, or real, yields on benchmark 10-year Treasuries are higher than for similar-maturity notes in Germany, the U.K. and Japan, according to data compiled by Bloomberg. That may help the U.S. lure foreign capital to finance the $1 trillion budget deficit even as Federal Reserve Chairman Ben S. Bernanke floods the global financial system with cash by purchasing $600 billion of government debt.

“The yield story is important for the dollar,” said Derek Halpenny, European head of currency research at Bank of Tokyo- Mitsubishi UFJ Ltd. in London, who predicts a 9.3 percent gain versus the euro next year and a 9.6 percent advance against the yen. “If we continue to see an improvement in economic data, that’s going to push U.S. yields higher.”

IntercontinentalExchange Inc.’s U.S. Dollar Index, which measures its performance against those of six trading partners, has risen 2.8 percent since Nov. 12, when the Fed began purchasing Treasuries in its second round of so-called quantitative easing. The U.S. 10-year real yield was 2.15 percent at the end of last week after averaging 1.74 percent during the past decade....

Even after rallying almost 6 percent from an 11-month low on Nov. 4, the dollar remains undervalued against 10 of the 16 most-traded currencies, according to a measure of purchasing- power parity compiled by the Organization for Economic Cooperation and Development in Paris that measures the relative prices of goods across countries.

Excerpt: Some investors see a “conspiracy theory” that the central bank causes a stock rally on days of its purchases, Bank of America Merrill Lynch strategists led by Jeffrey Rosenberg said in a Nov. 2 report.....

Nine of the S&P 500’s 10 main industry groups, led by shares of financial companies, rose more on days when the Fed opened its checkbook for, or announced results of, what it calls Permanent Open Market Operations. The group of 81 banks, insurers and investment firms, including New York-based JPMorgan Chase & Co. and Wells Fargo & Co. of San Francisco, climbed an average 0.32 percent, compared with a 0.04 percent drop on non- POMO days.

FX Concepts LLC, the world’s largest currency hedge fund, buys higher-yielding assets such as stocks and the Australian dollar when the Fed is purchasing bonds, said John R. Taylor, who manages about $8 billion as chairman of the New York-based firm. The days have become “incredibly important for the market,” Taylor said.

David Skidmore, spokesman for the Fed Board of Governors in Washington, and Deborah Kilroe, spokeswoman for the New York Fed, which carries out the purchases, both declined to comment.

The Fed’s purchase program, known as quantitative easing, works by increasing the quantity of bank reserves in the system. Policy makers direct the markets desk at the New York Fed to buy government securities from primary dealers, or brokers who are authorized to trade directly with the central bank, adding funds to the dealers’ accounts and creating reserves at their clearing banks. Financial firms were parking $979 billion of reserves at the Fed in excess of requirements as of Dec. 1, earning 0.25 percent interest....

Bank of America Merrill Lynch’s Rosenberg, who found shares outperformed on days when the Fed was buying, also cites economic data for the increases. “Correlation doesn’t equal causality,” said Rosenberg, head of global credit strategy in New York. ...

The Fed is “basically propping up stocks,” said Nicolas Lenoir, chief market strategist for ICAP Plc’s ICAP Futures LLC in Jersey City, New Jersey. “You should have good economic stats driving stocks up. The transmission of the wealth you create from stocks into real economic activity doesn’t work.”...

The central bank now is causing investors to hunt for yield by boosting demand for low-risk assets such as Treasuries, said Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida.

“If the ATM is spitting out $20s, you are more likely to take the money to the track than the mattress,” Saut said.